Tengiz – A Colossal Bet

“My name is Ozymandias, king of kings
Look on my works, ye Mighty, and despair!’
Nothing beside remains. Round the decay
Of that colossal wreck, boundless and bare
The lone and level sands stretch far away.”(1)


Nothing lasts forever – even finite resources.

In an earlier post I made a specific prediction that no new megaprojects would be sanctioned before end 2017 with a greater than net value of $10bn for any oil company (see here).

It appears I was wrong – Chevron and Exxon amongst others have sanctioned an expansion to the giant Tengiz oil field in Kazakhstan (above) for an estimated $37bn – given Chevron’s share is 50%, this is a net $18.5bn investment for them, and Exxon’s 25% share comes out at $9.5bn, so with almost certain over-run (see below), we’ll call that a round $10bn too.

The original reasoning was that lower for longer prices being a reasonable scenario for the short-medium-term (read 2016-17) and the historical and academically analysed inefficiency of these megaprojects, then it would be likely major firms would conserve capex, manage debt and protect dividends.

I did note the pro-investment culture of oil companies and their business model requirement for constant growth would be in tension with this capex control.

What is also clear is another significant aspect of international oil fields – they have time-limited awards of development leases. In the case of Tengiz, the lease expires in 2033, or only about 10 years after the project expansion is due to be finished. Although leases can be renegotiated, this is never certain, and lease conditions can change significantly. Hence Chevron and Exxon need to develop the fields now, or see the expected economic case deteriorate as uncertainty over the details of future reservoir ownership increases.

All major companies are likely to have such issues in their portfolios, so the pressure to continue to invest development capex into oilfield expansion, even if the current oil price or economic situation looks poor, will continue to increase.

And herein lies the paradox. If companies don’t invest, then its likely future oil supplies will be constrained, and prices will go up, making current production more valuable. If they do invest, then supplies may stay in balance, depressing prices. This is why some investors suggest minimal capex, reduced growth and greater profitability may be a lower risk strategy rather than continuing to invest heavily to keep a lid on prices.

The downside of this strategy is that the oil price surge is likely to prompt greater efforts to use alternatives, and refresh investment in unconventional sources of oil supply such as shale and oil sands.

Even if companies do invest, there is a looming problem for energy consumers: the inefficiency of large-scale extractive projects to meet energy demand growth.

Consider this: the Chevron Tengiz investment is estimated at $37bn to produce a net increase of 250,000 barrels per day by 2022. Let’s assume the project is on time and budget for a moment. If we take the BP Global Outlook base case for oil demand growth to 2035, this assumes oil demand growth of 0.9% pa, resulting in about 112 million barrels per day, or about 1 million barrels per day extra each year from now on to 2035. That is net of decline, which runs roughly at 3% pa, or about 3 million barrels per day each year.

So to stand still, we need to produce an extra 4 million barrels per day (bpd) each year on average.

In reality, due to processing gains and enhanced recovery techniques, and the lower decline rates of unconventional oils, the decline rate to manage may be 30-40% less than this – a rough calculation leaving 1.8 million bpd decline. This means an overall supply increase target of about 2.8 million bpd pa in relation to the BP base case.

Tengiz’s costs are thought roughly to be $40bn to produce an extra net 0.25 million barrels per day net increase. We therefore need about 11 Tengiz-scale projects coming online each year to keep increasing oil supply to meet demand and avoid price spikes. That equals about $450bn pa, which is roughly what the upstream oil industry was spending at its capex zenith in 2012-14

The US government energy advisory group EIA project the global number might be as high 130 million barrels per day by 2035 in high case scenarios, which on a simple ratio basis would be double the number above, or some $900 billion per year, just to keep oil supplies at a tolerable level.

Assuming the industry decided to go for such a massive investment spree, forgoing sacred dividends in the process, its also likely they would succumb yet again to the base rate performance of major projects – in which case the projected growth of the BP base scenario requiring $450bn pa would likely become $650-800bn pa and be several years late.

This is why megaprojects are such a high risk and late-coming tool for oil production growth, and why I made the initial (confident) forecast that they would not be used again in the near future: I still believe Chevron and Exxon are taking an extremely high risk bet with this countercyclical play.

Whatever the case,  all this logic lays bare a very concerning scenario used extensively in the oil analysis business at the moment – a massive surge in oil price is now likely due to investment discipline  postponing any other Tengiz-style investments, plus this will develop a far greater dependence on Middle East oil, in the medium term at least, for this is the only region where replacement production can be developed quickly.

However, before oil and gas investors and bulls get too excited, the fantastical investment and Middle East dependence scenario above is extremely dependent on level of demand estimates being correct.

And maybe those numbers are not so certain.

A new set of reports such as those by Enerdata and McKinsey Global Institute (MGI), are revising down expectations of overall energy demand growth out to 2035-2050. These types of predictions must always be handled carefully, but they are worth considering deeply even if only to use as a demand downside scenario.

Enerdata note that global GDP has dropped below 3% for the first time in decades, and has been on secular decline. Of the high growth countries, Brazil and Russia have been in recession, and China is stagnating as it moves beyond 20 years of industrial hyper-growth. India shows stronger growth, but is not developing at the same rate as China has been.

In terms of oil consumption, its clear that all the growth in demand we have seen in projections above is driven almost exclusively by vehicle increases in China and potentially India. How viable is that growth longer-term?

McKinsey have also begun to tackle this. They have a reduced global energy demand hypothesis based on three principles:

• GDP growth will slow over the next few decades even though the world population is growing larger – it is, but it is also growing older and less productive, as fewer people are in work as a ratio to employees
• Growth will be more services and light manufacturing based rather than heavy and industrial, hence less oil and gas intensive
• A major transition to electrical grids will reduce energy intensity, and oil demand growth, as, for example, EVs make larger inroads into transportation than expected

They forecast GDP growth of 2.1% over the next few decades, rather than the 3.8% of the previous decade, and energy growth of 0.7% as the trends above play out. For oil, they predict 0.4% growth overall, with a decline after 2030.

It’s worth summarizing their main findings and comparing with the industry standard BP Global Energy Outlook (GEO) 2016 base case, and their “stress scenario”.

MGI v2

The bad news from the McKinsey data is for global GDP – with the slowdown in China and Asia potentially causing economic slowdown globally. Productivity is required to fill the gap, but that is a subject of a wider report.

The good news is that taken at face value, the high case oil production and dependency scenario is far less likely. In this case, oil demand growth is effectively flat for the medium term, meaning only the underlying decline of 1.8million bpd pa has to be replaced.

The lower this figure, the more likely it can be met by cheaper and simpler sources of conventional oil supply, such as expansion of existing fields in the Middle East and elsewhere, or by shale oil, rather than needing to build any more Tengiz’s. The EIA’s latest projection for shale oil sees it increasing by over 2.5 million barrels per day over the next 15 years, increasing overall US production, for example.

Oil companies are also likely to invest heavily in incremental improvements in reservoir management to limit decline rates further overall, and make current production more efficient and valuable.

This may yet create a dependency on Middle East oil, but potentially at lower prices, as enhanced recovery, unconventional oil and alternative fuels such as electricity gradually mitigate the oil dependence created by transportation growth.

What it means for oil companies is that they can continue to conserve oil and reduce major capex requirements, but have to adapt to a world of cheaper oil, and service support to OPEC rather than employing stand-alone major investment ventures.

And if oil prices then remain in the historical band of $40-50/bbl due to much lower demand growth, then the ability of such large, complex plants such as Tengiz to meet near-term energy needs disintegrates – lower cost industry solutions such as enhanced recovery and shale oil will be used instead.

So, in a sense, Tengiz is a microcosm of the oil industry context today. Investments continue, but resources are finite. The end game strategy can be, and has been, deferred for decades of course, but an end game and exit strategy is eventually required. With this investment Exxon and Chevron have gambled that no such strategy will be needed for yet another decade.

History is of course on their side, but physics may not be: the greatest adversary these giant fields will confront is stealthy faceless pressure decline and economics. Long before the last hot sulphurous drop is retrieved, the field will have to be put to rest.

When that time is remains unclear – but Chevron and Exxon have just bet it is a very long way off.

It is of course hard to conceive today, looking at the vast expense of the Tengiz field, that such industrial giants may no longer be required in a few years time. Especially as the reason is something as abstract and mundane as incremental energy efficiency, and the rise of electric batteries and software in devices once referred to as “cars”.

But then the kingdom of Ozymandias too must have seemed eternal to those who built it and were part of it.

(1) – extract from the poem Ozymandias, Percy Bysshe Shelley, published 1818